Crowdfunding is a means of generating capital over the Internet, in which individuals pool their money for a common project or business venture. It became popular after President Obama signed the 2012 Jumpstart Our Business Startups (“JOBS”) Act into law. After its enactment, social media could be used as a capital-raising tool. If a nonprofit is knowledgeable, it can develop its own crowd fundraising effort but crowdfunding platforms are effective and efficient managers of a fundraising project. Now, platforms are large-scale enterprises that have seen incredible annual growth and have shifted crowdfunding from a niche idea to a mainstream funding solution.

Crowdfunding includes a wide variety of collective efforts and allows people to raise funds for almost any type of project with donations from others. It also refers to funding a for-profit company by selling small amounts of equity to a large number of investors. The sheer variety of projects, from funding a new movie to launching a consumer product to post-disaster fundraising, is a testament to the real promise of this new funding mechanism.

What are the benefits of crowdfunding for nonprofits?

Currently, the nonprofit sector must expend a significant portion of its resources on fundraising initiatives to maintain operations. Substantial amounts of time and effort are required to secure grants, persuade donors, and organize fundraising events. Essentially, one of the greatest challenges for nonprofits remains reaching a wide audience with their message and targeting relevant donors likely to agree with their cause. Nonprofits can approach crowdfunding as a means to diversify their funding while also appealing to a multitude of possible donors, thereby, enhancing their funding potential. Participation in crowdfunding allows an individual to search for a cause that both suits their interests and provides altruistic fulfillment.

As social causes are quickly gaining in popularity, substantial amounts of money are being raised through crowdfunding. In fact, in 2013, nonprofit organizations that engaged in crowdfunding raised more than five billion dollars worldwide. Studies have found that people are more concerned with funding an idea with which they agree than receiving a return on their investment. This suggests that people may view crowdfunding as a donations-based initiative which is beneficial for nonprofits.

What is an example of a nonprofit crowdfunding platform?

DonorsChoose.org is a 501(c)(3) that engages the public in public schools by giving people a simple, accountable and personal way to address educational inequity. It is an online charity that makes it easy for donors who want to help students in need. Public school teachers post classroom project requests on the website, and donors can give any amount to the project that most inspires them. When a project reaches its funding goal, DonorsChoose.org ships the materials to the school. Donors then get photos of the project taking place, a letter from the teacher, and insight into how every dollar was spent.

How does a nonprofit get started on a crowdfunding project?

Planning the perfect nonprofit crowdfunding campaign is no easy task. It takes preparation, creativity, and patience. Crowdfunding involves making a decision regarding tools. If the nonprofit is unable to implement its own fundraising website, choosing the right platform is important. The first consideration is whether or not the platform works with nonprofits (some platforms do not accept tax-deductible donations to a 501(c)(3) or support campaigns for charities). For example, Kickstarter is a popular platform but it can only be used to promote projects that create things to share with others such as art and gadgets, events and spaces, ideas and experiences. Kickstarter does not allow projects that promise to donate funds raised to a charity or cause.

After implementing a website or deciding on a platform it is important to (1) build a campaign by defining a project and its funding goals, producing a promotional video, and building a campaign page, (2) promote the campaign by understanding the community, creating a promotion plan, and publicizing the idea online, and (3) grow the community by sharing success stories, and updating and thanking supporters.

If using a platform, some platforms require that a minimum amount of pledges are received before disbursing funds. In this case, if the minimum amount of pledges is received by a certain deadline, the funds are transferred to the project. If the minimum is not reached, no one gets charged.

Finally, promotion of a project is a must and a nonprofit needs to tell its unique story through words, images and videos. There is no way of guaranteeing crowdfunding success, but by studying the projects, strategies and crowdfunding secrets that have worked for others, chances of success are more likely. Like any other business venture or marketing strategy, crowdfunding is an iterative process that starts long before a campaign is initiated.

How are contributions to a platform processed?

In order for a platform to accept donations to a 501(c)(3) campaign and issue tax receipts to donors, it must be a 501(c)(3) that utilizes a third-party payment processor or the platform regrants a contribution by using a donor advised fund.

Third-Party Payment Processor

A third-party processor uses its own merchant account to accept donations for other organizations. The third party processor passes on the donations to the nonprofit, minus a processing fee. There may be some delay in getting the funds into the nonprofit’s account and often the name that shows up on the donor’s credit card statement is not that of the intended nonprofit.

Third-Party Payment Processor Specializing in Nonprofits

Some third party processors specialize in nonprofit credit card processing, have a centralized website that you can refer donors to, offer other services such as sending acknowledgment messages, and website pages that can be branded by your nonprofit. A branded site, however, does not mean that the donor’s credit card statement will carry the receiving nonprofit’s name. Nonprofits using third-party processors commonly include information on the acknowledgment message to the donor about what they will see on their statements. Popular third party processors in this category include Network for Good or FirstGiving, which charges processing fees.

Donor Advised Fund

Some of the crowdfunding platforms, like JustGive and Razoo, operate a donor advised fund. Generally, a donor advised fund is a separately identified fund or account that is maintained and operated by a 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account.

Then, these donor advised funds regrant the contribution to the qualifying IRS recognized 501(c)(3) organization advised by the donor for a fee. A regrant to the advised organization is generally made one a month following receipt of the advised contribution.

How do contributors to a platform receive a tax-deductible receipt?

As mentioned, not all campaigns can offer tax deductions. According to United States tax laws, contributions must go directly to a 501(c)3 nonprofit organization in order for the contributor to be eligible for tax benefits. Campaigns that are set up to raise funds on behalf of a 501(c)(3) nonprofit organization will usually certify to contributors that funds will go directly to a verified nonprofit.

If a nonprofit payments processor or donor advised fund is used then when users contribute they will receive an email confirming the tax-deductible status of their contribution. Depending on the organization, the beneficiary nonprofit may issue a separate tax receipt as well.

If another third-party payment processor is used, the charitable organization is responsible for correctly classifying themselves and their transactions, issuing any required reports and receipts, and making any required tax or other filings. Contributors are responsible for verifying the status of organizations to which they donate and reporting their donations correctly for tax and other purposes.

A donor advised fund issues a tax receipt to donors (contributions are tax-deductible for U.S. taxpayers to the full extent permitted by law).

How does a 501(c)(3) receive its contributions from the platform?

When donors make donations to a 501(c)(3) through a platform, payments are sent directly to the address that the 501(c)(3) has on file with GuideStar. The 501(c)(3) will receive its donations less any transaction fees. The amount of the donation will be limited to the funds contributed minus the transaction fee charged by the platform.
What are the concerns about crowdfunding?

Solicitation

Crowdfunding allows an organization to gain national exposure with very little upfront capital. However, it also potentially exposes the organization to the jurisdiction of every state where it is believed to engage in charitable solicitation based on its crowdfunding efforts. Currently, thirty-nine states and the District of Columbia have laws governing charitable solicitation. Each state has its own unique laws and regulations regarding what qualifies as solicitation as well as the when registration is required.

There has been some debate as to whether internet activity, such as fundraising on crowdfunding platforms, triggers state solicitation registration requirements. Some guidance is provided under the Charleston Principles, nonbinding principles drafted by the National Association of State Charity Officials (NASCO). A copy of these principles is available at: http://www.afpnet.org/ResourceCenter/ArticleDetail.cfm?ItemNumber=3309.

Under the Charleston Principles, a nonprofit would be required to register for online charitable solicitations if the nonprofit solicits donations through an “interactive website”; and the nonprofit either: (i) “specifically targets persons” located in the subject state for solicitation; or (ii) receives contributions from the state on a “repeated and ongoing basis or a substantial basis” through its website.

Loosely Regulated Market

Despite all the excitement surrounding this means of fundraising, crowdfunding is not always the appropriate funding tool. Because crowdfunding is a loosely regulated market in which many investors are operating in a lightly scrutinized environment, there are still growing doubts about the ability to effectively ensure quality control, enforce project deadlines, and operate transparently on crowdfunding platforms. These concerns have dissuaded many people from utilizing and contributing through crowdfunding platforms.

Due to the quickly changing legal landscape, the Securities and Exchange Commission (SEC) has proposed amendments to regulations governing crowdfunding. However, these have not yet taken effect so some states are enacting legislation on their own. Illinois has drafted a proposed bill. Nonprofits will not be directly affected by the SEC rules because they only apply to equity crowdfunding. However, implementation of the SEC rules will probably raise public awareness and thereby create opportunities for nonprofits.

Can The Law Project Help?

The Law Project is a project of the Chicago Lawyer’s Committee for Civil Rights under Law, Inc. The Law Project matches eligible small businesses and nonprofits with pro bono legal counsel. For additional information about issues involving small businesses and nonprofits, please contact us at tlp@thelawproject.org or 312.939.3638, or visit us online at www.thelawproject.org.

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This communication is provided by The Law Project as a public service solely for informational purposes, without any representation that it constitutes legal advice by The Law Project. This neither creates an attorney-client relationship between the recipient and any other person, nor constitutes an offer to create such a relationship. Consult an attorney if you have questions regarding the contents of this communication.Sources:1. Lisa T. Alexander, Cyberfinancing for Economic Justice, 4 Wm. & Mary Bus. L. Rev. 309 (2013).2. Craigslist Founder Craig Newmark Releases Infographic on Success, Best Practices of Crowdfunding by Nonprofit Organizations, available at; http://www.prnewswire.com/news-releases/craigslist-founder-craig-newmark-releases-infographic-on-success-best-practices-of-crowdfunding-by-nonprofit-organizations-250953901.html.3. Elizabeth M. Gerber and Julie S. Hui, Pei-Yi Kuo, Crowdfunding: Why People Are Motivated to 4. Post and Fund Projects on Crowdfunding Platforms, available at: http://www.juliehui.org/wpcontent/uploads/2013/04/CSCW_Crowdfunding_Final.pdf.5. Julius A. Karash, SEC Crowdfunding Rules Pose Challenges, Create Opportunities (October 2, 2014).6. Edward Lee, Copyright-Exempt Nonprofits: A Simple Proposal to Spur Innovation, 45 Ariz. St. L.J. 1433 (2013).7. Andrew Read, Crowdfunding: An Empirical and Theoretical Model of Non-Profit Support (March 2013).8. Kara Ryan, Using Crowdfunding for Clients’ Financing Needs, Young Lawyers Journal (September 2014).9. http://www.donorschoose.org/about10. http://startsomegood.com/HowItWorks11. Indiegogo, How to Raise Tax-Deductible Funds, available at: http://support.indiegogo.com/hc/en-us/articles/202444736-How-To-Raise-Tax-Deductible-Funds12. IRS Donor Advised Funds, available at http://www.irs.gov/Charities-&-Non-Profits/Charitable-Organizations/Donor-Advised-Funds13. Nonprofit Crowdfunding Risks, available at: http://www.nonprofitlawblog.com/category/fundraising/14. http://www.illinoiscrowdfundingnow.com/15. Kickstarter Rules, available at https://www.kickstarter.com/rules